More than two years after the appellate briefing was completed, the Sixth Circuit has finally issued its decision in Quality Stores. (See our previous coverage here.) The court ruled that severance payments paid to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes. In so holding, the Sixth Circuit expressly declined to follow the Federal Circuit’s contrary decision in CSX Corp. v. United States, 518 F.3d 1328 (2008).

The court agreed with the taxpayer’s argument that the severance payments are not literally “wages” under the Code. Although Code section 3402(o) provides that “supplemental unemployment compensation benefits” (which the court found to include these severance payments) should be “treated . . . as wages” for income tax withholding purposes, there is no analogous directive for FICA. At the same time, relying on Rowan Cos. v. UnitedStates, 452 U.S. 247 (1981),the court ruled that the definition of “wages” is the same for income tax withholding and FICA purposes. (As discussed in prior posts, the government argues that intervening legislation has made Rowan no longer good law for that proposition.) Therefore, the court concluded, the Code does not make the severance tax payments subject to FICA taxation.

The government is likely to seek further review in this case. Given the clear circuit conflict, and the importance to the case of the continuing vitality of the Supreme Court’s decision in Rowan, this issue is certainly a candidate for Supreme Court review down the road.

A petition for rehearing is due on October 22. A petition for certiorari is currently due on December 6. That date would be pushed off if the government seeks rehearing.

As we previously reported, a district court in Michigan disagreed with the Federal Circuit’s decision in CSX Corp. v. United States, 518 F.3d 1328 (2008) (opinion linked here), and held that severance payments paid to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes. The employer, Quality Stores, has now filed its answering brief in the Sixth Circuit defending the district court opinion and addressing the arguments made by the government in its opening brief, and the government has filed its reply brief. (The briefs are attached below.)

The employer’s main argument is a textual one, based on the interplay between the FICA and income tax withholding provisions of the Code. Asserting that “wages” should mean the same thing in both sets of provisions, the employer relies on Code section 3402(o), which states that “supplemental unemployment compensation benefits” should be “treated as . . . wages.” Implicit in this provision, the employer asserts, is the proposition that such “SUB pay” would not otherwise be wages. Since the severance payments are encompassed within “SUB pay,” it follows that they are not “wages” for FICA purposes. (FICA does not contain a provision analogous to section 3402(o)).

The Federal Circuit in CSX had rejected the logic of this argument, reasoning that section 3402(o) might imply that some SUB pay is not “wages,” but not that all SUB pay is not “wages.” In addition to that relatively narrow argument, the government has suggested more broadly that the meaning of “wages” in the income tax withholding context “has no bearing” on its meaning in the FICA context. The Federal Circuit did not fully embrace that suggestion in CSX, stating that “we disagree with the government’s argument that after 1983, the term ‘wages’ in FICA must be interpreted without reference to the same term in the income tax withholding statutes.” In its reply brief in Quality Stores, the government focuses primarily on a narrower argument that accords with the Federal Circuit’s approach, contending that section 3402(o) was addressed only to the subset of SUB pay that had been exempted from withholding by certain Revenue Rulings. Because the payments in this case would not fall within those Rulings, the government reasons, section 3402(o) is irrelevant.

The employer also argues that the Sixth Circuit is bound by the Supreme Court’s decision in Rowan Cos. v. United States, 452 U.S. 247 (1981), to treat SUB pay the same for income tax withholding and FICA purposes. The government responds that Rowan cannot have that precedential effect after Congress overruled it and passed the “decoupling provision.”

With the briefing now concluded, the parties await the assignment of a date for oral argument, which will likely occur in the winter. The briefs are complex, and it remains to be seen whether the Sixth Circuit will immerse itself deeply in the issue or, instead, give considerable deference to the decision of its sister circuit in CSX.

On July 13, 2010, the government filed its opening brief in the Sixth Circuit in In re Quality Stores, Inc: United States v.Quality Stores, Inc., No. 10-1563. In that case, the government is appealing the district court’s surprising decision holding that severance payments made to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes if they qualify for exclusion from income tax withholding as “supplemental unemployment compensation benefits” (“SUB pay”) under Code section 3402(o)(2). As the district court acknowledged, its decision directly conflicts with the Federal Circuit’s ruling in CSX Corporation v. United States, 518 F.3d 1328 (2008), which had appeared to resolve this issue definitively in favor of the IRS. (This Miller and Chevalier Tax and Employee Benefits Alert contains a fuller discussion of the district court’s opinion and the steps that companies can take to protect their rights pending the outcome of the appeal.)

Although the government’s opening brief relies extensively on CSX, it also addresses the issues comprehensively as if the Sixth Circuit were the first circuit court to consider the issue. Primarily, the government argues that the case is controlled by Code section 3121, which broadly defines wages as “all remuneration for employment” — a definition that encompasses severance pay. The government criticizes the district court’s reliance on Code section 3402(o) both because that section relates to income tax withholding, rather than FICA taxes, and because its terms in any event do not dictate that SUB pay is not “wages.” With respect to the district court’s reliance on Rowan Cos. v. United States, 452 U.S. 247 (1981), the government argues that Rowan does not support exempting SUB pay from FICA taxation and, in any event, Congress’s enactment of the “decoupling provision” in the wake of Rowan eliminates any possible support that the case could lend to the companies’ position.

The answering brief for Quality Stores is currently due September 8, 2010. Links to the government’s brief and the district court opinion are attached.

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.